Excerpt:.....submitted the following facts. that the firm originally comprised of the four partners, namely, shri bhagwandas, kailashchandra, ramniwas and jitendra kumar. shri ramniwas and jitendra kumar retired and from 2-1-1978, smt. saraswati devi and the minor, shri rajendra prasad, became the new partners of the firm. as per the partnership deed, the share of profits/ losses to be shared by the partners was: mr. ranka further submitted that the firm in the immediately preceding year was granted registration.3. mr. ranka submitted that the ito did not grant the registration on couple of grounds. the first being that no partnership could be constituted between the huf and the coparceners of the huf. the second being, kailashchandra could not be examined in spite of opportunities provided. the.....

Judgment: 1. The assessee has come up in appeal against refusal of registration under Section 185(1)(b) of the Income-tax Act, 1961 ('the Act').

2. Mr. N. M. Ranka, the learned representative of the assessee, submitted the following facts. That the firm originally comprised of the four partners, namely, Shri Bhagwandas, Kailashchandra, Ramniwas and Jitendra Kumar. Shri Ramniwas and Jitendra Kumar retired and from 2-1-1978, Smt. Saraswati Devi and the minor, Shri Rajendra Prasad, became the new partners of the firm. As per the partnership deed, the share of profits/ losses to be shared by the partners was: Mr. Ranka further submitted that the firm in the immediately preceding year was granted registration.

3. Mr. Ranka submitted that the ITO did not grant the registration on couple of grounds. The first being that no partnership could be constituted between the HUF and the coparceners of the HUF. The second being, Kailashchandra could not be examined in spite of opportunities provided. The assessee could not at all state the nature of work done by Smt. Saraswati Devi, wife of karta of Shri Bhagwandas (HUF) and Shri Kailashchandra. Smt. Saraswati Devi in her statement stated that she was a sleeping partner, while the partnership deed did not mention this fact that she was a sleeping partner.

4. The entire work, according to the ITO, was done by Shri Bhagwandas alone and, therefore, he was of the view that the partnership was not a genuine one. Mr. Ranka drew our attention to page 19 of the paper book, where the officer had granted the registration of the firm in which Shri Bhagwandas, Kailashchandra along with two others were partners for the assessment year 1978-79. Mr. Ranka, therefore, submitted that it was admitted by the department that Shri Kailashchandra was a partner in the immediately preceding assessment year and merely because in the present assessment year Shri Kailashchandra could not present himself, cannot lead to the conclusion that he was not a partner in the firm.

5. Mr. Ranka further submitted that there is no requirement that all the partners must work in the firm. Merely because Smt. Saraswati Devi mentioned in her affidavit that she was a sleeping or dormant partner and this fact was not mentioned in the partnership deed, could not be the ground for treating the firm as a non-genuine one. Mr. Ranka pointed out that the department is satisfied that Smt. Saraswati Devi had contributed capital. For this purpose, he drew our attention to page 25, where the capital accounts of the partners have been filed.

The quantum of capital contribution is not a very relevant one ; though Smt. Saraswati Devi has contributed a sum of Rs. 6,000 only, the Income-tax Department has been satisfied that she had, in fact, contributed this capital. The grievance of the department is that the fact that she was a dormant partner, was not mentioned in the partnership deed. For the proposition that any one partner can act on behalf of all the partners, he relied on several judgments including the case of Subhash Medical Stores v. CIT [1984] 147 ITR 486 of the Rajasthan High Court. He also relied on this judgment for the paltry sum of contribution by some partners. Regarding the dormant partners, he relied on United Patel Construction Co. v. CIT [1966] 59 ITR 424 (MP) and in the case of K.D. Kamath & Co. v. CIT [1971] 82 ITR 680 (SC).

6. For the proposition that there could be partnership between the karta of the HUF and the coparceners, Mr. Ranka relied on Lachhman Das v. CIT [1948] 16 ITR 35 (PC), Ramchand Nawalrai v. CIT [1981] 130 ITR 826 (MP), CIT v. Gupta Bros. [1981] 131 ITR 492 (All.) and CIT v.Gaekwade Vasappa & Sons [1983] 143 ITR 1 (AP). Mr. Ranka, therefore, stated that the firm, in which Shri Bhagwandas (HUF) was a partner, was allowed registration in the earlier years and in the year merely because he carries on the activity of the business for and on behalf of the partners, it cannot be said that he is acting as a benamidar of the partners. He, therefore, pleaded that in view of the various submissions, the firm is a genuine one and the registration must be granted.

7. Mr. Ruhela, the learned departmental representative, submitted that the requirement of a genuine firm has been elucidated in 121 ITR 361 (Bom.) (sic). Mr. Ruhela pointed out that para 16 of the partnership deed mentions that Shri Kailashchandra shall have no criminal liability. Shri Kailashchandra had stated that he was away at Delhi and, therefore, could not produce himself before the ITO. Mr. Ruhela further states that Shri Bhagwandas had a capital contribution of Rs. 72,000, Shri Kailashchandra contributed Rs. 18,000 and Smt. Saraswati Devi contributed only Rs. 6,000. At the end of the year, the balance in the account of Shri Bhagwandas (HUF) was only Rs. 6,215, which only indicates that capital was not at all required for the firm. As per the partnership deed, Shri Bhagwandas shall be responsible for looking after the day-to-day business of the firm. According to Mr. Ruhela, since this has been provided, and in view of the fact that Shri Kailashchandra remains in Delhi and Smt. Saraswati Devi is a sleeping partner, it could only be concluded that there is no genuine partnership amongst the partners. Shri Bhagwandas is the sole proprietor of the concern.

8. We have heard the parties. The basis of refusing registration by the ITO is: (a) that the HUF and the coparceners cannot form a partnership firm ; (c) Smt. Saraswati Devi states in her affidavit that she was a dormant partner, but this fact was not mentioned in the partnership deed; and (d) the control of the business was with Shri Bhagwandas and, therefore, the contribution of the firm was only on paper. In these cases, now, we would deal with each of these issues in seriatim.

9. The decisions relied upon by the representative, Mr. Ranka, as also the later decisions of the Madras High Court in the case of CIT v.K.T.S. Nagamanickam Chettiar [1984] 148 ITR 115 go only to indicate that a valid partnership could be constituted between the karta of HUF and some of its coparceners. In this judgment, their Lordships have referred to the Privy Council's case in Lachhman Das (supra). In the case before the Privy Council, the fact was that the partnership firm was constituted between the HUF and one of the coparceners in his individual capacity. The observation of the Privy Council was reproduced in the above judgment, which is again reproduced here for easy reference: After careful consideration, their Lordships cannot accept this view and on general principles they cannot find any sound reason to distinguish the case of a stranger from that of a coparcener who puts into the partnership what is admittedly his separate property held in his individual capacity and unconnected with the family funds. Whatever the view of a Hindu joint family and its property might have been at the early stages of its development, their Lordships think that it is now firmly established that an individual coparcener, while remaining joint, can possess, enjoy and utilise, in any way he likes, property which was his individual property, not acquired with the aid of or with any detriment to the joint family property. It follows from this that to be able to utilise this property at his will, he must be accorded the freedom to enter into contractual relations with others, including his family, so long as it is represented in such transactions by a definite personality like its manager. In such a case he retains his share and interests in the property of the family, while he simultaneously enjoys the benefit of his separate property and the fruits of its investment.

To be able to do this, it is not necessary for him to separate himself from his family. This must be dependent on other considerations, and the result of a separate act evincing a clear intention to break away from the family. The error of the Income-tax Officer lay in his view that, before such a contractual relationship can validly come into existence, 'the natural family relationship must be brought to an end'. This erroneous view appears to have coloured his and the subsequent decisions of the Income-tax authorities.

In this view of the Hindu law, it is clear that if a stranger can enter into partnership, with reference to his own property, with a joint Hindu family through its karta, there is no sound reason in their Lordships' view to withhold such opportunity from a coparcener in respect of his separate and individual property.

Respectfully following the Privy Council's decision in Lachhman Das's case (supra), we hold that a partnership firm could be constituted between the HUF and its coparceners in their individual capacity.

10. Shri Kailashchandra was one of the partners of the firm in 1978-79 and the firm had been granted registration vide order of the ITO, dated 8-11-1979. Merely because in the subsequent year, he could not produce himself before the ITO, it could not be used against the assessee for refusing the registration. It is unimaginable that the same partner could be a partner in the earlier year and accepted as such by the department, but in the subsequent year it could be doubted that he was a partner at all or not. The capital contribution of this partner, is not in doubt. In view of the fact that he was a partner in 1978-79 and continues to be so in the reconstituted firm, it could only be concluded that he was a partner in the firm for the assessment year 1979-80 as well.

11. In the case of Smt. Saraswati Devi, the department is harping on the fact that she had stated in the affidavit that she was a dormant partner. The Madhya Pradesh High Court decision in United Patel Construction Co.'s case (supra) is to the effect that a partnership may comprise some member known as a dormant or a sleeping partner, who is not generally interested in the conduct of the business and who cannot be expected to be aware of the details of the partnership business. But it cannot be reasonably inferred from her ignorance about the details that the partnership was not genuine.

12. The ITO is entitled to enquire whether an instrument of partnership is intended by the parties to be really effective as governing their rights and liabilities inter se in relation to a business of whether it is only a pretence to escape liability for tax, But a conclusion that a partnership is not genuine cannot be granted on suspicion. From the above judgment, it is patently clear that there could be a dormant partner in a business and merely because this fact has not been so mentioned in the partnership deed does not make the deed an ingenuine one.

13. The last ground on which the registration was not granted, was that Shri Bhagwandas was enjoying the full control of the business. The issue of one partner entitled to full right of control and management of the business and operation of its bank account, came up for consideration before the Supreme Court in the case of K.D. Kamath & Co.

(supra). Their Lordships of the Supreme Court observed: ...that the fact that the exclusive power and control, by agreement of the parties, was vested in one partner, and the further circumstance that only one partner could operate the bank accounts or borrow on behalf of the firm was not destructive of the theory of partnership provided two essential conditions were satisfied, namely: (i) that there should be an agreement to share profits and losses of the business of the firm ; and (ii) that the business must be carried on by all the partners or any of them acting for all.

Clause 5 read with other clauses showed that the first condition, namely, all persons agreeing to share profits or losses, was satisfied. The second condition was also satisfied: even though vast powers of management and control had been given to K, the business was being carried on by him on behalf of all the partners. Both the ingredients of partnership were satisfied and the firm could be granted registration under Section 26A. Held also, that the provision in clause 9 of the deed was only an inter se arrangement entered into by the partners in and by which the working partners had agreed not to raise loans or pledge the firm's interest. Not only was the clause not destructive of the theory of partnership but it indicated that the theory of agency was recognised.

The above observation, therefore, clearly supports the case of the assessee that the mention in para 9 that the first party shall be responsible for looking after the day-to-day business of the firm, is only an inter se arrangement between the partners and is only recognising the theory of agency. Each partner is an agent of the other partner as far as the firm and outsiders are concerned. This has been clearly brought out by the Supreme Court in the above quoted order.

This being so, Shri Bhagwandas having powers of control and management is only an inter se arrangement between the other two partners (the other being minor). Respectfully following the Supreme Court decision in K.D. Kamath & Co.'s case (supra) the ITO's action in not granting registration on this ground is incorrect and invalid. We, therefore, direct the ITO to grant registration to the firm.